It seems that many investors shun ethical or ‘green’ funds, following fears that they won’t be able to keep up with their competitors because of their small stock pools.
Providing appealing returns or attractive dividends while also keeping a portfolio ethical can look to be challenging – currently, 13.25 per cent of the FTSE 100 index and 11.28 per cent of the FTSE All Share consists entirely of oil & gas stocks, for instance.
This means that when the FTSE is delivering a strong performance, ethical funds can lag behind. What’s more, many blue-chips that may not be suitable for ethical investors are currently offer attractive dividend yields which are, in some cases, in excess of 6 per cent. 
Tristan Scrivens (pictured), director of Elm Financial Management, says it is incredibly rare that he encounters a client who is interested in ethical funds or would like to build an ethically-screened portfolio.
“It makes it quite difficult for the managers to put something together and to get income from it, because those areas are where the dividend stocks usually are,” he said.
“When I ask clients if they have any preference as to where their money is invested, the majority of them will say that they would just like an income, or they would just like a capital gain, for example. I do bring it up and ask if there is anything they don’t want to invest in but, the general consensus I find is that, as long as the company is above board, they’re happy.”
However, while some funds, particularly ‘dark green’ funds that adopt ultra-strict ethical screening techniques, frequently underperform, there is a number of ethical funds that are nevertheless shooting the lights out.
Over five years, the ethical fund that has achieved the highest total return is Premier Ethical, which has been managed by Chris Wright since 2009 and has significantly outperformed both its peer average in the IA UK All Companies sector and its FTSE4Good UK benchmark.
Performance of fund vs benchmark and sector over 5yrs
Source: FE Analytics
The £107m fund avoids companies that bare any relation to tobacco, pornography and weapons of mass destruction, but also aims to invest in companies that are improving their ethical behaviour of promoting ethical causes.
Also, in an article published last month, the FE Research team reviewed the 218 funds in the Investment Association universe that have SRI specifications and awarded 13 of them a place in the FE Invest Recommended list.
Among the top-rated ethical funds were Henderson Global Care UK Income, CIS Sustainable Leaders and Alliance Trust Sustainable Future Absolute Growth.
Charles Younes, fund analyst at FE Research, said: “Despite the fact that the market for ethical investments has grown quite a fair bit in recent years, there is still a distinctive lack of guidance for consumers who want to park their money in a more socially responsible manner.”
“For advisers of more ethically-minded clients the lack of true guidance backed up by research makes it that much more difficult to pinpoint just which fund does what it says on the label.”
One ethical fund house that is well-known for the strong performance of its funds is Edentree, formerly known as Ecclesiastical.
For instance, their EdenTree UK Equity Growth fund is the thirteenth-highest performer over five years in the IA UK All Companies sector, providing a return of 123.63 per cent.
Performance of fund vs sector and benchmark over 5yrs
Source: FE Analytics
Neville White, head of SRI policy and research at EdenTree, told FE Trustnet that with the right management, it isn’t difficult for an ethical fund manager to outperform.
“We look for stocks that will be there for the long term but are also making a positive contribution to society as well as likely to be long term performers for shareholders,” he explained.
“We very much believe that, if you do the due diligence around the investment screening and also integrate responsible investment, you can build long term portfolios that will have successive value for customers and clients.”
As a house, EdenTree avoid the classical basket of gambling stocks, alcohol, arms and pornography. They also avoid stocks related to intensive farming or companies that use animal testing for cosmetics and beauty products.
Across their portfolios, EdenTree don’t hold any miners and have only minimal exposure to oil & gas companies on environmental and human rights grounds.
“When BP had its catastrophic accident at Deepwater Horizon and lost nearly half of its value, none of our clients suffered from that loss of value. In fact BP still hasn’t recovered – it’s a third lower than it was before the accident in 2010,” White pointed out.
Performance BP versus index since 2010
Source: FE Analytics
“BP is still paying a very strong dividend, but we might argue about how sustainable that dividend is given the catastrophic fall from grace that BP has had. All oil is under pressure. Easy oil is gone, exploration is getting harder. Where oil is now at $60, what a lot of oil companies have been searching for because oil is now so difficult to get, isn’t going to be economically viable at that price.”
While EdenTree investors would have breathed a sigh of relief a few years ago, Scrivens argues that ethical funds can still land investors in hot water.
“Ethical funds spread their stock across fewer sectors and this is something they’re largely unable to control,” he said.
“A lot of the ethical funds are heavy in financials at the moment, for example. For investors who only consider ethical funds, what you find is they aren’t realising they could be doubling or even tripling up on some sectors.”
While this may be the case, White says that there are benefits to investing ethically other than being able to align your principles with your portfolio.
He believes that, through buying into ethical funds, investors can increase the resilience and long-term durability of their portfolios.
“Yes, some oil companies are delivering very high dividends but, if that’s your only criterion for investing, then you ignore all the other risks around the world,” he said.
“It depends on what your motivator is. There are people who will invest purely on principle, and there will also be people that invest who are more interested in risk, and I think, where responsible investing is a really interesting concept is around risk avoidance.”
“When you put the two together you have a holistic way of building portfolios that isn’t just looking at the investment case which can turn on a penny, but actually the responsible investment case tends to be a longer term view of the business.”
“We just think over time you get better performing portfolios because you’ve really taken this into account.”
